Duncan and Commissioner of Taxation (Taxation)

[2020] AATA 2540

Duncan and Commissioner of Taxation (Taxation) [2020] AATA 2540 (30 July 2020)

Administrative Appeals Tribunal

ADMINISTRATIVE APPEALS TRIBUNAL              )
  )         No: 2019/0368
GENERAL DIVISION  )

Re: John Duncan
Applicant

And: Commissioner of Taxation
Respondent

DIRECTION

TRIBUNAL:  Mrs J C Kelly, Senior Member

DATE OF CORRIGENDUM:            3 August 2020

PLACE:           Sydney

The Tribunal directs the Registrar, pursuant to subsection 43AA(1) of the Administrative Appeals Tribunal Act 1975 (Cth), to alter the text of the decision in this application such that:

1. on the last page, “Solicitors for the Applicant: Ms E Munro, Munro Lawyers” and “Solicitors for the Respondent: Mr A Koch, Australian Taxation Office” is replaced with “Solicitors for the Applicant: Munro Lawyers” and “Solicitors for the Respondent: Australian Taxation Office”, respectively.

..............................[sgd].....................................

Mrs J C Kelly, Senior Member

Division:TAXATION AND COMMERCIAL DIVISION

File Number(s):      2019/0368

Re:John Duncan

APPLICANT

AndCommissioner of Taxation

RESPONDENT

DECISION

Tribunal:Mrs J C Kelly, Senior Member

Date:30 July 2020

Place:Sydney

The objection decision made on 21 November 2018 is affirmed.

.............................[sgd]...........................................

Mrs J C Kelly, Senior Member

CATCHWORDS

TAXATION – whether outgoing incurred in gaining or producing assessable income – whether outgoing of capital or of a capital nature – whether Applicant acted in his capacity as a director – insolvent trading – company in liquidation – decision under review affirmed

LEGISLATION

Corporations Act 2001 (Cth) 180-184, 198G, 438B, 439A(4), 530A, 588G, 588M

Income Tax Assessment Act 1997 (Cth) s 8-1, 995-1

Taxation Administration Act 1953 (Cth) s 14ZZK

CASES

FCT v Sydney Refractive Surgery Centre (2008) 172 FCR 557

Federal Commissioner of Taxation v Day (2008) 236 CLR 163
Federal Commissioner of Taxation v Smith (1980) 147 CLR 578
Hallstroms Pty Ltd v Commissioner of Taxation (1946) 72 CLR 634
Smithkline Beecham Laboratories (Australia) Ltd v Commissioner of Taxation (1993) 116 ALR 503

Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337

REASONS FOR DECISION

Mrs J C Kelly, Senior Member

30 July 2020

Introduction

1. The Applicant, Mr Duncan, claims that the sum of $100,000 (the Outgoing) is deductible from his assessable income for the year ending 30 June 2017 pursuant to s 8-1 of the Income Tax Assessment Act 1997 (Cth) (the ITAA 1997).

2. The reviewable decision is the objection decision made on 21 November 2018 which disallowed the deduction and remitted the previously imposed administrative penalty in full.

3. The Respondent relies on s 14ZZK of the Taxation Administration Act 1953 (Cth) (the TAA) to place on the Applicant the burden of proving all facts upon which it seeks to rely, except for facts the Respondent has expressly agreed to or admitted.

   How did the Outgoing arise?

4. How the Outgoing arose is not in dispute. The following summary is supported by reliable documentary evidence.

   The Applicant’s Role with Keystone Group

5. Keystone Australia Holdings Pty Limited (KAH) operated as a holding company of 41 subsidiaries including Keystone Group Holdings Pty Ltd (KGH). Those entities will be referred to as the Keystone Group. The Keystone Group owned restaurants, bars and hotels in various capital cities around Australia.

6. The Applicant was employed by entities in the Keystone Group from at least 16 September 2000[1]. He has been a director of various entities in the Keystone Group since 1999.[2]

   [1] T9-229.

   [2] T4-102 to 104.

7. On 15 April 2011 the Applicant became a director and Secretary of KGH when it was incorporated.[3] From 2014 he was a director of all the companies in the Keystone Group except KAH.[4]

   [3] T4-101.

   [4] T4-102 to 104.

8. KGH acted as the Keystone Group’s employer and treasury company.[5]

   [5] T4-57.

9. On or about 15 August 2014, the Applicant commenced as an employee of KGH pursuant to an Executive Employment Agreement dated 30 July 2014 (the EEA).[6] His position was Chief Property & Corporate Development Officer.

   [6] T9-227 to 246.

10. The EEA included the following relevant provisions:

    …

    3.1  Your employment shall commence on the 15^th August 2014 and continue until determined by notice in accordance with the provisions of this employment contract.

    3.2 The parties replace with this contract with (sic) all previous agreements and understandings in relation to the Employment from 16^th September 2000, and will apply to all Employment of the Employee, despite any change in position or title, unless otherwise agreed in writing.

    5.2  During the course of the Employment, the Employee must provide services to and hold offices within the Employer’s related bodies corporate, as required by the Employer.

    …

    11. Remuneration and Benefits

    11.1 The employee will be paid a salary of $250,000.00 less tax, per annum.  This amount is inclusive of superannuation contributions.

    11.2  Your remuneration package will be reviewed annually and may be adjusted at The Company’s discretion …

    …

    23 Appointment to and Resignation from Offices

    23.1 The Employer may during the Employment, request that the Employee hold offices with the Employer and/or its Related Bodies Corporate. Unless otherwise agreed in writing, these offices will be held without any further remuneration to the Employee.

    23.2 On termination of the Employment for any reason, the Employee must, at the request of the Employer, resign from any office (including the office of director) held by the Employee in the Employer or its related Bodies Corporate without claim for compensation.

11. In about June 2015, the Applicant was appointed managing director of the Keystone Group.[7]

    [7] Applicant’s Statement of Facts, Issues and Contentions [10].

    External administration of the Keystone Group

12. On 28 June 2016:

    ·Creditors of the Keystone Group appointed Morgan Kelly and Ryan Eagle of Ferrier Hodgson as Receivers and Managers of the Keystone Group (the Receivers).[8]

    ·Katherine Elizabeth Barnet, Henry Peter McKenna and Hugh Armenis of Bentleys Corporate Recovery Pty Ltd were appointed joint and several administrators of the Keystone Group by resolution of directors for each company in the Keystone Group (the Administrators).[9]

    [8] T4-52.

    [9] T4-52 and 54.

13. Shortly after the Administrators were appointed, they reached agreement with the Receivers which enabled the Keystone Group’s businesses to continue to trade at the direction of the Receivers.[10]

    [10] T4-52.

14. In a letter dated 30 August 2016, the Receivers referred to a meeting held with the Applicant on 26 August 2016, specifically with respect to discussions regarding the sale process being undertaken by the Receivers and their requirements for the assistance of the Directors in that process. It referred to the obligations of Directors under the Corporations Act 2001 (Cth) (the Corporations Act) to provide assistance to the Receivers in that context.[11]

    [11] T9-247 to 248.

15. In a letter to the Applicant dated 9 September 2016, the Receivers set out incentive arrangements and requested the Applicant to sign the enclosed copy to indicate his acceptance, which he did.[12] Conditions included that the Applicant remain an employee of the Keystone Group and comply with his duties under ss 180 to 184 of the Corporations Act. Each of those provisions applies to a director or other officer of a corporation. The incentives included two payments. The first was for $62,500 with an entitlement and payment date of 30 September 2016. The Applicant claims he received that payment. He did not claim to have received the second payment of $125,000.

    [12] T9-249 to 254.

16. On 30 January 2017, the Administrators issued a Report to Creditors pursuant to s 439A(4) of the Corporations Act (the Report).[13] Part 10 of the Report was entitled “Administrators’ Investigations”. Part 10.2 was entitled “The Keystone Group’s Solvency”. In part it stated:

    Our view is that the Keystone Group demonstrated many indicia of insolvency from at least 31 December 2015, if not earlier, as set out below:

    [13] T4-47 to 161.

17. It then set out a table summarizing those indicia.

18. The Report addressed Insolvent Trading at Part 10.6. There, it referred to the powers of a liquidator, including those set out in ss 588G and 588M of the Corporations Act which provide that a liquidator may seek to recover from the director/s of a company any debt incurred by the company after a time that a reasonable person would suspect that the company became insolvent. It also set out defences available to directors. Part 10.6 concluded:

    Should it be determined there is a potential claim against the Directors the position would be calculated with reference to the incurring of debts between the date of insolvency and our appointment.

    Further investigation would be needed to ultimately quantify an insolvent trading claim (if any) for the individual companies in the Group.

    A liquidator (if appointed) will be able to investigate any potential insolvent trading claim in greater detail.[14]

    [14] T4-81.

19. The conclusion of Part 10, at 10.9, stated:

    If creditors resolve that companies in the Keystone Group be wound up, the Administrators will become the liquidators of these companies. The liquidators will conduct further investigations of those companies’ affairs and may seek to obtain litigation funding. If the liquidators determine that it is not economic to pursue an insolvent trading claim, or is unfunded and cannot otherwise obtain funding for that purpose, creditors may commence their own proceedings in respect of certain voidable transactions provisions.

    Liquidators are also required to submit a report to ASIC pursuant to Section 533 of the Act reporting any offences identified.

    Creditors should note that an administrator’s investigation is not as detailed as an investigation conducted by a liquidator. A liquidator is empowered to conduct further investigations and commence proceedings where rights exist.[15]

    [15] T4-82.

20. Part 12 was entitled “Alternatives Available to Creditors”. Three alternatives were considered: The Keystone Group companies execute Deeds of Company Arrangements; the Administrations should end; or The Keystone Group companies should be wound up. In relation to the second, the Report concluded:

    As the Group is insolvent and the Receivers have either sold or closed all of the Group’s businesses we do not recommend that creditors resolve to end the administrations.[16]

    [16] T4-84.

21. The Administrators recommended that each company listed in an annexure be wound up and provided reasons.

22. By a letter dated 28 April 2017, the Receivers notified the Applicant that his employment with KGH would be terminated by reason of redundancy and that the final date of employment was 31 May 2017.[17] It included the following:

    Any property owned by the Group or related entities must be returned on or before your final day of employment. Please make the necessary arrangements for their return (this includes site access keys/passes, cars, car keys, laptop computers and mobile phones).

    [17] T9-257 to 259.

23. Creditors voted to wind up the Keystone Group and on 5 May 2017 the Administrators were appointed Liquidators.[18]

    [18] Applicant’s Statement of Facts, Issues and Contentions at [19].

24. The Receivers wrote to the Applicant on 19 May 2017 to advise him that his final day of employment was now 19 May 2017.[19]

    [19] T9-260 to 262.

25. On or about 28 June 2017, the Applicant received his PAYG payment summary form for KGH for the year ending 30 June 2017 from the Receivers.[20]

    [20] T9-265 to 266; see also T9-268.

    Payment of the Outgoing

26. On 30 June 2017:

    ·The liquidators executed an agreement with a Hong Kong registered company, DEM Aspirion Limited, to assign the right to sue various directors, including the Applicant, under s 100-5 of Schedule 2 of the Corporations Act.[21]

    ·The Applicant entered into a deed of release of settlement with DEM Aspirion Limited.[22]

    ·DEM Aspirion Limited issued to the Applicant a Tax Invoice for $100,000 in “Full and final settlement of all or (sic) legal actions against John Duncan in his role as a director of the relevant entities in the Keystone Group of Companies for trading while insolvent”.[23]

    ·The Applicant arranged for the invoice to be paid.

    Was the Outgoing incurred in gaining or producing the Applicant’s assessable income under s 8-1(1)(a) of the ITAA 1997?

    [21] T5-168 to 178; T9-255 to 256.

    [22] T5-168 to 178.

    [23] T4-46.

27. The Outgoing was incurred in the year ending 30 June 2017. The Applicant was employed and earned assessable income in that year. The question is whether the Outgoing was incurred in gaining or producing the Applicant’s assessable income under s 8-1(1)(a) of the ITAA 1997.

28. The Applicant accepted in its written submissions in reply that the main issue to be decided was whether the temporal requirements of s 8-1(1)(a) of the ITAA 1997 are met. That was in response to the Respondent’s claim in its written submissions that there were two independent reasons why the Applicant did not satisfy that provision:

    i.As at 30 June 2017, the Applicant was not employed by the Keystone Group and had no ongoing entitlement to receive assessable income from the Keystone Group; and

    ii.The Outgoing was incurred in relation to an alleged failure by the Applicant to comply with his former obligations as a director to prevent insolvent trading.

29. The first proposition is correct as a statement of fact. The second would be more accurately stated as the Outgoing was incurred in relation to the possibility that the Applicant had failed to comply with his obligations as a director to prevent insolvent trading sometime in the period before the Administrators were appointed on 28 June 2016.

30. As a matter of fact, the Applicant’s directorships were an incident of his employment.

31. The Applicant’s case was that his employment caused his exposure to the Outgoing. More accurately, the claim is that the Applicant incurred the Outgoing as a result of carrying out his duties as a director in the course of his employment.

32. The terms of s 8-1(1)(a) of the ITAA 1997 and its predecessors have not been regarded as materially different.[24]

    [24] Federal Commissioner of Taxation v Citylink Melbourne Ltd (2006) 228 CLR 1 at 30 [90] per Crennan J.

33. The relevant principles are set out by Gummow, Hayne, Heydon and Kiefel JJ in Federal Commissioner of Taxation v Day (2008) 236 CLR 163 (Day). Their Honours held that the legal expenses incurred in relation to charges laid under the Public Service Act 1999 (Cth) against a customs officer were properly allowable as deductions under s 8-1(1)(a) of the ITAA 1997. In the present case, the parties accepted that the Outgoing was of a legal nature. It was paid to avoid incurring legal expenses of litigation.

34. At [21] and [22], their Honours said:

    The terms of s 8-1(1)(a) of the ITAA and its predecessors[25] have not been regarded as materially different[26]. They refer to a relationship between expenditure incurred and what is productive of assessable income, which is to say the connection necessary for deductibility[27]. The words "incurred in gaining or producing … assessable income", appearing in the section, have long been held to mean incurred "'in the course of' gaining or producing" income, as was observed in Payne[28]. In Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation[29], Latham CJ explained that it was necessary to read "losses and outgoings … incurred in gaining or producing the assessable income" as incurred "in the course of" gaining or producing that income, in order to make the section[30] intelligible. Outgoings may have an effect in gaining income, but losses cannot, as they simply reduce income[31]. In Commissioner of Taxation v Cooper[32] Hill J observed that an outgoing might be referable to a year of income other than that in which it was incurred[33]. That was a reason why s 51(1) of the Income Tax Assessment Act 1936 (Cth) did not express the right to a deduction in terms of outgoings incurred to earn income[34]. The words "in the course of" therefore facilitate the application of s 8-1(1)(a). They do not require a direct connection between the expenditure in question and an activity itself productive of income.

    Dixon J in Amalgamated Zinc said that the expression "incurred in gaining or producing the assessable income" should be given a very wide application[35], although in that case the taxpayer company's continuing liability to pay monies to a compensation fund for miners it had employed lost any connection to assessable income when its business ceased. In Payne the majority confirmed that the words require more than a causal connection between the expenditure and the derivation of income; something closer and more immediate. The expenditure must be incurred "in the course of" gaining or producing the assessable income[36]. Their Honours' reference to the words "in the course of" should not be taken to suggest a closer or more direct connection between expenditure and that which is productive of assessable income than the words of the provision[37] themselves convey. Rather the words draw attention to the connection made necessary by the provision, which the majority considered on the facts of that case to be too remote.

    [25] Income Tax Assessment Act 1936 (Cth) s 51(1); Income Tax Assessment Act 1922 (Cth) s 23(1)(a).

    [26] Federal Commissioner of Taxation v Citylink Melbourne Ltd (2006) 228 CLR 1 at 30 [90] per Crennan J; [2006] HCA 35.

    [27] Federal Commissioner of Taxation v Payne (2001) 202 CLR 93 at 99-101 [9]-[13] per Gleeson CJ, Kirby and Hayne JJ, 112 [51] per Gaudron and Gummow JJ.

    [28] Federal Commissioner of Taxation v Payne (2001) 202 CLR 93 at 99 [9] per Gleeson CJ, Kirby and Hayne JJ (emphasis added), referring to Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295 at 303 per Latham CJ, 309 per Dixon J; Ronpibon Tin (1949) 78 CLR 47 at 56-57; Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344 at 350.

    [29] (1935) 54 CLR 295.

    [30] Income Tax Assessment Act 1922 (Cth) s 23(1)(a).

    [31] Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295 at 303 per Latham CJ.

    [32] (1991) 29 FCR 177.

    [33] (1991) 29 FCR 177 at 197, referring to Federal Commissioner of Taxation v Smith (1981) 147 CLR 578; [1981] HCA 10.

    [34] Commissioner of Taxation v Cooper (1991) 29 FCR 177 at 197.

    [35] (1935) 54 CLR 295 at 309.

    [36] Federal Commissioner of Taxation v Payne (2001) 202 CLR 93 at 101 [13] per Gleeson CJ, Kirby and Hayne JJ.

    [37] Income Tax Assessment Act 1936 (Cth) s 51(1).

35. At [32] and [33] their Honours said:

    … A determination as to what is productive of assessable income in a particular case may need to take account of any number of positive and negative duties to be performed or observed by an employee or other salary-earner. It is that determination which provides the answer as to whether the occasion is provided for the expenditure in question.

    That no narrow approach should be taken to the question of what is productive of a taxpayer’s income is confirmed by cases which acknowledge that account should be taken of the whole of the operation of the business concerned in determining questions of deductibility. A similar approach should be taken to what is productive of a salary-earner’s income, whether it be described as employment or by reference to a bundle of tasks to be performed and duties to be observed. …

36. The Applicant argued that in the year of assessable income being gained or produced, that is, the year ending 30 June 2017, the Outgoing was entirely connected to that assessable income and, to a similar effect, had a relation to the assessable income. The Applicant also argued that the focus should include prior years.

37. The Applicant argued that the “fact of cessation of employment, incidentally for reasons outside of (sic) his control (ie, redundancy), just prior to the payment of the (Outgoing), is not a precluding fact to the application of s 8-1”.[38]

    [38] Applicant’s Submissions in Reply dated 6 August 2019.

1. That statement does not reflect the Applicant’s role in the Keystone Group or what actually happened. The Applicant was an employee, including as the managing director for a time, and a director of entities within the Keystone Group which went into receivership and administration and finally, into liquidation. The Applicant paid the Outgoing to discharge a liability he may have incurred as a director of Keystone Group entities prior to the appointment of the Administrators.

2. The Respondent conceded in its written submissions that the Applicant remained a director of the relevant Keystone Group entities at 30 June 2017. During oral submissions, the Respondent argued that the cessation of his employment implied that he had been requested to resign from his directorships. That was said to be the conclusion to be drawn from the letter of 28 April 2017 which requested him to return property of the Keystone Group “on or before your final day of employment” and cl 23.2 of the EEA.

3. The Applicant relied on a letter from one of the receivers dated 23 March 2018 which stated that the Applicant remained a director of the Keystone Group after his employment ended on 19 May 2017 and “accordingly, his responsibilities as a director continue”.[39]

   [39] T6-183.

4. From 19 May 2017, when his employment ended, the Applicant received no financial benefit from the role of director of the Keystone Group entitles, assuming he continued in that role. From 5 May 2017 when the liquidators were appointed, the Applicant had no reasonable expectation of future employment by, or remuneration from, the Keystone Group.

5. The Applicant did not incur the Outgoing in order to preserve his employment which had ended on 19 May 2017. The advantage the Applicant sought by incurring the expense was unrelated to the maintenance of his employment. The Applicant implicitly conceded that was so at [82] of its Statement of Facts, Issues and Contentions where it stated that the Applicant was entitled to act defensively to protect his standing as a director of the Keystone Group as at 30 June 2017.

6. The Keystone Group was under external administration from 28 June 2016 when the Administrators were appointed.[40] From that date, the Applicant’s duties as a director of the relevant entities were very limited. Section 198G(1) of the Corporations Act provides that while a company is under external administration, “an officer of the company must not perform or exercise a function or power of that office”. Section 198G(2) makes it an offence for a director to purport to exercise any function or power as a director.

   [40] See the definition of external administration in Sch 2, s 5-15 of the Corporations Act and s 198G(9).

7. The Corporations Act confers very limited and defined duties on directors of a company under external administration. Some examples are:

   ·a director can act with the written approval of the external administrator (s198G(3)(b));

   ·a director must help the administrator by providing certain books, a report, and information about the company (s 438B); and

   ·a director must help the liquidator by providing certain books and information to a liquidator (s 530A(1) and (2)).[41]

   [41] “Officer” of a corporation includes a director: s 9 of the Corporations Act.

8. In the circumstances set out above, the Outgoing was incapable of resulting in any future income for the Applicant from the Keystone Group as an employee or as a director, which was incidental to his employment.

9. The Applicant put the following submission relying on Day. In Day the High Court thought that expenditure incurred by an employee taxpayer to defend a charge which may have resulted in dismissal was sufficient to establish the necessary connection to employment or service which is productive of income. In this case, the factual enquiry fixes on the requirement of directorships as part of the Applicant’s employment which establishes connection to the employment which is productive of income.

10. The argument is flawed. In Day, the employee was seeking to maintain his employment by defending the charges. In this case, the Applicant was not. He incurred the Outgoing after his employment ended. It is implicit in the Applicant’s argument that the directorships were required as part of his employment and that the directorships ended when his employment ended. His employment was productive of income. If his directorships continued after his employment ceased, they were not productive of income. The connection found in Day between the expenditure and employment productive of income, is not found in this case.

11. Again relying on Day at [39], the Applicant argued that the objective relationship between the Outgoing and that which is productive of income will provide a sufficient answer to the inquiry posed by the section. “(T)he question whether the expenditure has been incurred “in gaining or producing income” will look to the scope of the operations or activities and their relevance to expenditure, rather than to a taxpayer’s reasons for the expenditure”.[42]

    [42] Day at [39] per Gummow, Hayne, Heydon and Kiefel JJ, referred to in the Applicant’s Submissions in Reply [10] dated 6 August 2019.

12. That argument was in response to the Respondent’s submission that the Outgoing was seemingly to preserve the Applicant’s “personal, professional standing as a leader and potential director in the hospitality industry”.[43]

    [43] Respondent’s Submissions [50] dated 16 July 2019.

13. The consideration at [47] above is of the objective relationship between the Outgoing and what is productive of income as set out in Day at [39].

14. The Applicant submitted that the expenditure was incidental and relevant to the operations from which the income is produced as discussed in Federal Commissioner of Taxation v Smith.[44] At [585] to [586], Gibbs CJ, Stephen, Mason and Wilson JJ said:

    The section does not require that the purpose of the expenditure shall be the gaining of the income of that year, so long as it was made in the given year and is incidental and relevant to the operations or activities regularly carried on for the production of income. What is incidental and relevant in the sense mentioned falls to be determined not by the reference to the certainty or likelihood of the outgoing resulting in the generation of income but to its nature and character and generally to its connection to the operations which more directly gain or produce the assessable income.

    [44] (1980) 147 CLR 578.

15. The “connection” between the expenditure and that which produces assessable income has to be determined. Their Honours were referring to ongoing operations, not to past operations. There is not the necessary connection in this case for the reasons set out at [47] above.

16. There was a causal connection between the Outgoing and the derivation of income (before 28 June 2016). However, as was said in Day, more is necessary, “something closer and more immediate”.[45]

    [45] Day at [22].

17. The Respondent argued that insolvent trading is not a normal, natural or necessary consequence of company directorship, however given the above findings on the s 8-1(1)(a) issue it is unnecessary to consider that argument.

18. There were some references to s 8-1(1)(b) during the Applicant’s case, however I understand that it was not pressing an argument based on that provision. For certainty, I find that the Applicant’s occupation was as an “employee”. He was not carrying on a business as defined in s 995-1 of the ITAA 1997.

19. For the above reasons, the Outgoing was not incurred in gaining or producing the Applicant’s assessable income. The Applicant does not satisfy the positive limbs of s 8-1(1)(a) of the ITAA 1997.

20. Those findings are sufficient to conclude this matter, however, following is consideration of one of the negative limbs of s 8-1(2)(a) of the ITAA 1997.

    Was the Outgoing of capital, or of a capital nature pursuant to s 8-1(2)(a) of the ITAA 1997?

21. Section 8-1(2)(a) of the ITAA 1997 provides that a loss or outgoing cannot be deducted if it falls into any one of four categories. The first category is s 8-1(2)(a): “a loss or outgoing of capital, or of a capital nature”.

22. In Sun Newspapers Ltd v FCT, Dixon J stated that:

    The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.[46]

    [46] (1938) 61 CLR 337 at 359.

23. His Honour directed attention to three matters: (a) the character of the advantage sought; (b) the manner in which it is to be used, relied upon, or enjoyed; and (c) the means adopted to obtain it. That statement of principle is not disputed.

24. The Applicant submitted that the character of the advantage sought by payment of the Outgoing is “inexorably tied to the fact that (that sum) was paid by reason of the Applicant’s employment” and cannot be dissected from employment. It arose from his day to day income earning activities. The Applicant referred to Hill J’s statement in Smithkline Beecham Laboratories (Australia) Ltd v Commissioner of Taxation:

    … there can be little doubt that expenditure incurred to preserve or to protect a business as such will ordinarily be expenditure of capital: cf FCT v Consolidated Fertilizers Ltd (19910 22 ATR 281; 101 ALR 385 at 399-400 per Spender and Lee JJ. On the other hand, where legal costs are incurred in defending the taxpayer and its officers from criticism of its methods of trading, the outgoings will clearly be on revenue account: FCT v Snowden & Willson Pty Ltd (1958) 99 CLR 431 at 437 per Dixon CJ; 7 AITR 308; [1958] ALR 523.[47]

    [47] (1993) 116 ALR 503 at 22.

25. The Respondent referred to Dixon J’s statement in Hallstroms Pty Ltd v Commissioner of Taxation (Cth) (1946) 72 CLR 634 which it submitted demonstrated the importance of ascertaining the purpose of legal expenditure:

    … legal expenses, we may assume, take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or the purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them (emphasis added).[48]

    [48] At [647] Dixon J was in dissent. However, his statement was later approved by the High Court in Broken Hill Theatres Pty Ltd v FCT (1952) 85 CLR 423 at 434.

26. The advantage sought in this case was to avoid litigation in which the Applicant would be accused of being a director of a company or companies which traded while insolvent. It was to protect and preserve the Applicant’s reputation as a director of a company and an employee, and his capacity to earn income as such in the future. That is consistent with the Applicant’s legal advice from Munro Lawyers dated 14 July 2017 which described the “purpose of the payment” being to prevent potential litigation by DEM Aspirion Ltd that would “have had a direct impact on (the Applicant’s) professional standing and his ability to continue to take a leading role in the hospitality industry”.[49]

    [49] T4-165.

27. In context, Hill J’s statement in Smithkline Beecham Laboratories (Australia) Ltd v Commissioner of Taxation[50], was in relation to an ongoing business. That is not analogous to this case.

    [50] (1993) 116 ALR 503.

28. In FCT v Sydney Refractive Surgery Centre, the Full Court of the Federal Court held that business reputation is akin to a capital asset.[51] The Court approved a number of international statements including that “reputation is a basis for inducing others to engage in market or nonmarket transactions with you” and injury to reputation impairs future earning capacity.[52]

    [51] (2008) 172 FCR 557.

    [52] (2008) 172 FCR 557 at [12].

29. The character of the advantage sought in this case indicates the capital nature of the Outgoing.

30. The manner in which the Applicant will rely on the advantage gained from the Outgoing is the preservation and protection of his reputation and earning capacity as a company director and employee in the future. While not decisive, the lasting nature of an advantage is a relevant factor to consider.[53] In this case it points to the capital nature of the Outgoing.

    [53] Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 at 362.

31. The means adopted to secure the advantage was a one-off payment. Again, while not decisive, recurrence is relevant to whether an outgoing is of a revenue nature.[54] The consideration points to the Outgoing being of a capital nature.

    [54] Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337 at 362.

32. I find that the Outgoing was of a capital nature.

33. Given the above findings, it is unnecessary to address the Applicant’s submission that the Outgoing was not an outgoing of a private or domestic nature.

    Decision

34. The objection decision made on 21 November 2018 is affirmed.

I certify that the preceding 71 (seventy-one) paragraphs are a true copy of the reasons for the decision herein of Mrs J C Kelly, Senior Member

.............................[sgd]...........................................

Associate

Dated: 30 July 2020

Date(s) of hearing:	12 August 2019
Counsel for the Applicant:	Mr S Richardson
Solicitors for the Applicant:	Ms E Munro, Munro Lawyers
Counsel for the Respondent:	Ms C Burnett
Solicitors for the Respondent:	Mr A Koch, Australian Taxation Office